Capital Economics Warns AI-Driven Market Bubble Is Reaching Its Final Stages

Capital Economics indicates that while the S&P 500 possesses additional upside for the current year, its medium-term trajectory appears unfavorable due to excessive market exuberance. “Most indicators suggest the AI equity boom is nearing an end,” stated senior market economist James Reilly in a recent note. Capital Economics has maintained a more optimistic stance than most peers since mid-2023, driven by the belief that artificial intelligence will serve as a transformative force. The firm’s year-end 2026 S&P 500 projection has consistently exceeded consensus estimates. However, the firm has also asserted that the AI-fueled rally constitutes a bubble destined to burst.

To identify and evaluate a late-stage market bubble, Reilly examines eight indicators: valuations, earnings, index concentration, equity issuance, and foreign interest in U.S. equities. Several of these metrics have already reached or approached levels historically observed prior to previous market peaks. The analysis reveals that while certain variables, such as earnings expectations, align with a market top, others like volatility and leverage appear slightly less threatening.

Earnings represent the most significant warning sign. Expectations for S&P 500 earnings growth currently match levels seen exclusively at the zenith of the dot-com bubble, while long-term EPS growth forecasts have surged to unprecedented highs. Reilly notes that the heavy concentration of anticipated growth within the technology sector implies that any deterioration in tech firm earnings will disproportionately drag down the index.

Additional indicators are flashing warning signals. Index concentration has reached dot-com-era extremes, net equity issuance has turned positive, and foreign ownership of U.S. equities stands at a record high. Reilly warns that another surge in IPOs and share offerings could be particularly consequential, as similar issuance booms have historically coincided with market peaks.

“Based on historical precedent, this suggests the bubble’s end is merely months away, not years,” he stated.

Although leverage measures are not yet alarming compared to other factors, the analyst cautions that they are trending in a “concerning direction.” While volatility metrics align with a mid-stage bubble, Reilly observes that constituent-level volatility is not as extreme as it was near the conclusion of the dot-com boom.

“While we continue to anticipate that the S&P 500 will rally from approximately 7,650 currently to 8,250 by the end of 2026, we ultimately forecast it to retreat to 6,500 by the end of 2027,” he wrote. These assumptions translate to an 8% gain this year and a 21% decline in 2027.

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